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  • Writer's pictureMike

#15 - Risk Tolerance and Risk Capacity

If you google Risk, you'll find it's a game (a good one, too), or possibly the loss of something important, or injury. In reality, none of us can escape it. In the self defense realm, a phrase that's gone around a lot goes something like "it's not the odds, it's the stakes," and many have a singular interpretation of that. After all, if we carry all the things, then nothing can hurt us (maybe) - but what did we miss out on in life as a result?

I believe the financial industry is a better at holistic approaching risk, while mitigating the negative risk while maximizing the positive rewards (on the whole, not including speculators). The Money Guy Show talks a fair amount about risk and making a clear, defined difference between risk tolerance (our attitudes) and risk capacity (our finances). Being a cowboy with risk with our last $2 is a good example of misappropriating risk, while being a cowboy with 2% of our play money may be appropriate on the risk/reward spectrum.

The financial world thinks about opportunity cost frequently. Opportunity cost is the end gap between two different decisions, and is the basis of "You can afford anything, but not everything." A basic example of this would be $1,000 in a savings account, compared to $1,000 invested in the total economic market and the gap created over a period of time.

Opportunity cost applies to a lot once we reframe it - eating out constantly generally results in immediate satisfaction and less money, while cooking from home takes more effort for the same result with less expenditure. When dining out, will carrying a Roland special negatively impact the event with our significant other, or will a J frame offer better chances of making memories with those we love?

My point is simple - we have to understand why we're pursuing something to stick with it, right? That same understanding is what allows us to calculate opportunity cost for our individual situation, regardless the subject matter. We can calculate using our feelings, which is what subjectively works the best (underwear gun or duty gun). It's also possible to calculate opportunity cost coldly using math, accepted practices, and academic research. Once we know a why, and have a general ability to look at real-life (and financial) opportunity cost, we've set ourselves up to probably live a better life for ourselves.

After all, "A ship is safe in harbor, but that is not what ships are for" - and is often something Dr. William Aprill was known for referencing.



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